Greenspan's warning for China

The former Federal Reserve chairman Alan Greenspan says China's stock market is heading for a crash, threatening to ruin millions of middle-class investors. By Clifford Coonan
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The Independent Online

In old-style Communist China, the stock market was a potent symbol of evil capitalism and the rise to power of Mao Zedong's hard-line Communists in 1949 brought an end to share-owning capitalism in China. Stock ownership was a capital offence.

These days, the middle class in the world's fourth-largest economy has gone equities-crazy. First-time investors, ranging from taxi drivers to Buddhist monks, pensioners to students to cash-rich entrepreneurs, are engaged in a frenzy of share buying that has seen prices rise 50 per cent this year and prompted fears of a speculative bubble. The former US Federal Reserve chairman Alan Greenspan's warning on Tuesday that the bubble might burst was therefore a potential disaster for millions of Chinese - particularly as market setbacks following his speech suggest the prophecy could be self-fulfilling.

In the first four months of this year, the capital markets siphoned more than 70bn yuan (£4.6bn) out of savings accounts in Shanghai alone, according to the People's Bank of China. Last Wednesday, the Shanghai index passed the 4,000-point mark for the first time, and is heading for 5,000 at high speed, economists say. Trading volume on that day in Shanghai and China's second smaller exchange in the southern city of Shenzhen exceeded all other markets in Asia, including regional giant Tokyo.

This year's 50 per cent rise in the Shanghai Composite Index, comes on top of a 130 per cent increase in 2006. The market shrugged off a one-day drop of nearly nine per cent on 27 February, a correction blamed for a subsequent sell-off on US and European bourses.

That slide was prompted by investor panic over reports that officials might reimpose a capital gains tax. Although China's security markets are not important in global terms - only 3 per cent of investment comes from abroad - investors seemed to read it as a bellwether for the overall state of the economy. The media are full of stories of people getting rich quick - wily pensioners and canny schoolkids making millions through lucky deals - prompting comparisons with the happy-go-lucky atmosphere in America before the Wall Street Crash in 1929.

Fears of a stock-market frenzy have prompted officials to warn against irrational exuberance. The prospect of millions of inexperienced retail investors losing everything if the stock market were to crash would have politically destabilising effects that the government, which keeps a tight grip on single-party rule, is not prepared to risk. If the Chinese market does crash, it will have a major impact on other global markets, depending on what point in the cycle it hits.

Economists are wary of calling the current market rise a bubble, but they are seeking measures to stop expansion before a bubble emerges. Jonathan Anderson, chief economist for Asia at UBS in Hong Kong, reckons the Beijing government is close to intervening. "It's true that 'traditional' macro-policy tools like base money constraints or interest-rate hikes don't have much impact on the equity market," said Mr Anderson. "However, unlike the US or other developed markets, the Chinese regulators have no qualms about using direct administrative tools to affect asset markets once they reach a consensus that something needs to be done. We believe that the recent A-share market gains have brought the authorities to that point," he said. "We already saw the full gamut brought to bear on the property sector, and we expect further use of administrative restrictions on the equity side as well," said Mr Anderson.

People are crowding into shares because there are few enough other vehicles around to invest your money in. The government has clamped down on speculation in the property market to stop housing costs soaring, interest on bonds is low, and most individuals are not allowed to invest abroad. Even though the savings rate in Chinese families is high at up to 40 per cent of incomes, bank accounts pay just 3 per cent interest - less than the rate of inflation.

Many new investors lack basic knowledge of the stock market and the China Securities Regulatory Commission (CSRC) has called on stock exchanges, securities dealers and other authorities to educate investors about the risks of investment. They want the institutions to tell investors that shares can go up as well as down, and not to use all their savings or mortgage their apartments to invest in stocks.

Zhou Zhengqing, a top financial adviser on the National People's Congress Standing Committee and a former chairman of the China Securities Regulatory Commission, said he believed share-owning culture was developing well in China, but urged patience.

"Compared with mature markets, China's securities market is still in its infancy. The quality of investors is not high enough. The regulatory system is not mature enough. We must improve risk education for new investors and ensure they have a clear understanding of the risks ahead," Mr Zhou told the People's Daily.

Li Hengren, 65, a retired manager from Beijing, has been hooked on share buying for two years. "Since I retired, I've got a lot of spare time on my hands, so I've been buying stocks to pass the time. I don't have any real opinions about the stock market and I don't even care that much about the result of my investments. I'm just playing for fun," said Mr Li.

Li Rong, 22, a graduate student at Tsinghua University, loves to buy shares, and believes there has never been a better time to climb on board. China is booming, after all. She and her boyfriend started investing earlier this year and have invested 800 yuan (£53) and 1,000 yuan (£66) respectively. "When evaluating the development of the Chinese stock market, I am still very optimistic. Frankly, things are trapped in a state of disorder right now so obviously I'm not planning to make any big deals at the moment until things calm down," said Ms Li. But long-term she remains keen on the idea of investing in shares.

China's cabinet, the State Council, sought opinions from six prominent economists last month on the soaring stock market, and four said current share valuations are acceptable. Last week, the Beijing government said it would raise the amount that Chinese banks are allowed to invest in stocks abroad, possibly diverting some of the money pouring into domestic markets. But economists said the amounts involved will be too small to affect the country's money flows.

Optimists point out that the macroeconomic picture in China remains resolutely healthy. The country's massive trade surplus with the rest of the world has left it with plenty of cash. The economy is expected to expand by around 10 per cent during yet another year of huge economic expansion in 2007.

Share prices are trading at 30 to 40 times earnings, an unusually high ratio for many major markets, which some say makes them unrealistic, but earnings growth too is strong. "The view is that this is not a bubble right now. The market has expanded 200 per cent in the past 24 months but it's still not so expensive that it's a bubble. Maybe there will be a short-term correction but we expect a rising market over the next three years," said Mr Anderson. "What this market really needs is to get better companies, to give better confidence and encourage more companies to list. And there are signs of better companies, national champions, coming to markets."

The Shanghai stock market reopened in 1990 after four decades in the ideological wilderness but its performance has been mixed since. There was a similar boom in 1999, when soaring markets drew in millions of new investors before prices plunged in 2001, wiping out speculators. There were reports of suicides by indebted investors. Back then the market was described as being not much different from a casino. Given that gambling remains illegal in China, perhaps the current rush to invest in stocks is partially fuelled by an urge for a flutter.

China's stock market: how it works

China operates two stock exchanges on the mainland, in Shanghai and Shenzhen, as well as the Hong Kong Stock exchange, which is entirely separate.

The Shanghai bourse is the larger of the two - the Chinese government maintains a controlling interest in many of the companies listed in Shenzhen - but the combined total market was capitalised at around $500m at the end of last year.

Domestic investors have a choice of around 900 stocks, but two types of share are traded. A shares, with prices in the local currency, were originally off-limits to overseas investors, though this restriction was relaxed to some extent in 2002. B shares, meanwhile, are priced in US dollars, tradable by both domestic and foreign investors. The Chinese government plans eventually to merge the two classes.

Investment amongs the Chinese middle classes has until recently been limited, but has rocketed over the past year.

According to the China Securities Depository and Clearing Corp, which is jointly owned by the Shanghai and Shenzhen stock exchanges, the number of trading accounts has risen by 30 per cent over the past year to 95 million. One sixth of these have been opened in the past four months, and on one day alone last week, investors opened 552,559 new accounts.

The sage of China

Lin Yuan, China's best-known day trader and private investor, said yesterday that the share price correction had not spooked him. Mr Lin, who has become a celebrity after turning an initial 8,000 yuan (£520) investment made 18 years ago into a portfolio that is now worth more than 1bn yuan, said he was staying invested.

"Don't ask me whether the bull run has peaked - the stock market will be in an uptrend in the long run," Mr Lin said. "My principles are simple: I nearly always invest every penny in the market - to win in the stock market, you must invest everything there for most of the time."

Mr Lin's investment career has prompted comparisons with Warren Buffett, the "sage of Omaha". Mr Lin has a similar affable manner and approachable reputation.